Just try and answer a hypothetical once in your life. It won't kill you, you might learn something. I don't even understand your criticism of the apples and oranges point. Its just a question, just answer it. We can argue all day about whether it applies at all to the real world, but just leave your baggage behind for a minute and think about it as a pure intellectual question.

Anyway, if you don't answer the question, I'm done responding. Its clear you don't want to engage on an intellectual level. Is the person worse off, better off or as well off or you can't tell?

If you don't want to respond to a simple question, which may or may not have any relevance to economics or the real world, just so we can start to find some common ground, then have a nice day sir, enjoy your life.

Just try and answer a hypothetical once in your life. It won't kill you, you might learn something. I don't even understand your criticism of the apples and oranges point. Its just a question, just answer it. We can argue all day about whether it applies at all to the real world, but just leave your baggage behind for a minute and think about it as a pure intellectual question.

Anyway, if you don't answer the question, I'm done responding. Its clear you don't want to engage on an intellectual level. Is the person worse off, better off or as well off or you can't tell?

If you don't want to respond to a simple question, which may or may not have any relevance to economics or the real world, just so we can start to find some common ground, then have a nice day sir, enjoy your life.

Your reading comprehension leaves MUCH to be desired. I did answer it (WORSE OFF, go back and read) -- in the context of monetary inflation.

But now let's answer your completely irrelevant apples to oranges question--as best as it can be answered.

Originally Posted by ababba

I have an income of 10 dollars in year one. I buy five apples and five oranges in year 1, each of which cost one dollar. In year 2, the price of apples increases to 2 dollars and I decide to buy 10 oranges with my 10 dollars. What is the rate of decrease in my standard of living?

ANSWER: The "rate" (of decrease or increase) cannot be answered without a definition of "rate" (of what, precisely?) AND "standard of living". Apples and oranges are both in the fruit category, but are nonetheless unlike things. Since I assume that I am consuming the fruit and not buying it for direct resale, or as a factor of production to some finished good for resale, I can only gauge the "standard of living" based on its utility, or what you receive from each, and what you lost or gained through the substitution.

Oranges have slightly more Vitamin C on average, so your Vitamin C "standard of living" increased slightly.
Oranges have Folate, where apples contain none, so your Folate "standard of living" increased substantially.
Oranges have almost twice as much Potassium on average than apples, so your Potassium "standard of living" increased substantially.
Apples have about twice as much fiber as oranges, so your Fiber "standard of living" decreased substantially.
Apples have slightly more calories on average, but it's negligible, so your Caloric Intake "standard of living" remains roughly the same.
Because apples are not oranges, your Fruit Variety "standard of living" went DOWN substantially.

Now we get to your preference, which is wholly subjective, but you it brought up. When both apples and oranges were priced equally, you bought equal amounts of each. What I do not know, and it would be ridiculous for me to assume, is why you made those choices on that day, or whether you would demonstrate this same preference again, all other things being equal. Furthermore, I don't know how much of your decision is made on the basis of economics vs. health vs. taste preferences (or "other"?). It is quite possible that you would have bought all apples if they were priced the same as oranges. If so, then you're even a bigger loser, and WORSE OFF than if you would have made the same choice as before had the prices been the same.

See that? I can talk about the differences between apples and oranges, but since these are YOUR BUYING PREFERENCES, I am not in a position to tell YOU whether or not you are better off, worse off, or as well off. I am also not in a position to tell YOU what has happened to your "standard of living", because you have not phrased it as an economics question.

And that's just the tip of the iceberg, after both humoring you and cutting through your horse shit of a question. Did I miss something? Or is this one of those cases where you stomp your feet in a huff and say, "Bah! Such a simple question, but he just doesn't get it."

And, btw, answer your own question, and tell me why, specifically, you answered that way. I am really curious to see how you process your own information.

EDIT: BTW, if you try to invoke the strawman argument that I am implying that ALL price differences and changes between unlike things are all because of the Fed, you will be officially out to lunch--because such a universal and absolute pronouncement is not, nor has it ever been, my claim.

The burden is on you to show how an apples to oranges substitution relates to PRICE INFLATION. And if you call it something else, the burden is on you, once again, to make the logical connection between PRICE INFLATION and whatever relativistic, equivocating term you have inserted as a substitution.

I am just trying to get at a very basic Micro Economics fact. If you change relative prices of goods but give someone enough to be able to afford their old consumption bundle at the new prices, then they must be better off.

Why? Because they can afford their original bundle but relative prices have changed. They can do no worse and now there is an entire set of new possibilities that they couldn't afford before but they can afford now.

Its the reason why if you give someone just enough to be able to buy what they bought last year but relative prices have changed, they will actually be better off.

Thus, if social security is based off of a shadowstats index, an attempt to make seniors no worse off by indexing will actually make them better off than the previous year, because of substitution.

I am just trying to get at a very basic Micro Economics fact. If you change relative prices of goods but give someone enough to be able to afford their old consumption bundle at the new prices, then they must be better off.

Why? Because they can afford their original bundle but relative prices have changed. They can do no worse and now there is an entire set of new possibilities that they couldn't afford before but they can afford now.

That isn't "a very basic Micro Economics fact". In fact, it's gibberish. What the hell does that mean: "If you change relative prices...but you give someone enough..." - Who is doing all of this? Who is 'changing' relative prices, and by what mechanism, and who is 'giving someone enough'? You think you're talking Micro Econ, but you're doing it with gibberish, and from a decidedly statist, monetarist Macro Econ social engineering perspective. Which then begs more questions...which you evade while pretending to talk Micro Econ only...which you are not.

You throw out terms like "...able to afford their old consumption bundle...", in the context of substitutions that are NOT the old consumption bundle at all!
Your standard for "better off" is also flawed for a number of reasons. For one, you take EXTREME liberties with "better off" attribution for things NOT ATTRIBUTABLE TO MONETARY INFLATION; things like efficiency and technological improvements, which, it can be argued, might otherwise have been greatly INCREASED in the absence of wasteful resource misallocation and malinvestment. Ergo, we could be much WORSE OFF, because you have completely ignored the potential LOSS OF AN OTHERWISE GAIN.

Once again, you are fixated on the notion that so long as someone's "standard of living" (as YOU loosely, presumptuously and subjectively define it) remains the same, nobody is harmed in the process. That is an absolute absurdity, which brings back full circle to the point I made--which you ignored. So here it is again, to give you another opportunity to address it. You don't have to answer. You can attack the phrasing or relevance of my question--but not out of ignorance or hand-waving dismissal. At least be logical about it.

You think that if you can demonstrate a zero-sum-game, (i.e., so long as people can make substitutions, or can afford exactly the same shit), that you can then argue that they are "as well off", if not "better off" (in the context of CURRENCY DEBASEMENT and resulting PRICE INFLATION).

ONCE AGAIN: You hold stock. That stock periodically pays you dividends. I steal those dividends, intercepting them, forging your signature, and cashing those checks EVERY TIME YOU RECEIVE THEM. And let's say that you're none the wiser. You didn't even know you had a dividend coming. Furthermore, I don't touch your stock. That's yours to keep. Can I now declare with a straight face that you are "no worse off" than before, or "as well off" as before, and is there anything whatsoever even meaningful about that?

Oh, and to sweeten the pot, as we roll up our sleeves and decide things for others: What if I see you can't quite afford next year what you could last year, and "give you enough to be able to afford" yada yada yada. Would that make you "better off", if I, as a thief, did that for you?

It's a simple question. If you think it doesn't apply, or has no relevance, EXPLAIN WHY.

Its the reason why if you give someone just enough to be able to buy what they bought last year but relative prices have changed, they will actually be better off.

WTF is with your "if you give someone just enough"? You make it sound as though allowances are being doled out from some parent figure who is looking over your shoulder and approving a personal budget. What the fuck kind of Orwellian bullshit planet are you living on?

Furthermore, what you said MADE NO SENSE! How can having just enough to be able to buy next year as last year make anyone BETTER off? Explain. Is your Inflation Normalcy Bias so freakishly ingrained in you that merely keeping pace with an artificial treadmill counts AS A GAIN?! The fucking gain would be if there was no treadmill, and you actually ADVANCED.

Thus, if social security is based off of a shadowstats index, an attempt to make seniors no worse off by indexing will actually make them better off than the previous year, because of substitution.

Holy crap, what a loaded, screamingly fallacious, compound question. "...and attempt to make seniors no worse off by indexing..." WTF DOES THAT MEAN? What does that mean, first of all, and who, exactly, is trying to do whatever-that-means?

I deliberately avoided reference to that monstrously tortured scam called Social Security, and its relation to CPI. We're talking about the CPI and its accuracy or inaccuracy with regard to price inflation only, without respect to anything else. Even so, wow. Total meltdown--"...better off than the previous year, because of substitution(?!)..." is absolute gibberish! How is that true, and what, exactly, does that have to do price inflation?

That isn't "a very basic Micro Economics fact". In fact, it's gibberish. What the hell does that mean: "If you change relative prices...but you give someone enough..." - Who is doing all of this? Who is 'changing' relative prices, and by what mechanism, and who is 'giving someone enough'? You think you're talking Micro Econ, but you're doing it with gibberish, and from a decidedly statist, monetarist Macro Econ social engineering perspective. Which then begs more questions...which you evade while pretending to talk Micro Econ only...which you are not.

You throw out terms like "...able to afford their old consumption bundle...", in the context of substitutions that are NOT the old consumption bundle at all!
Your standard for "better off" is also flawed for a number of reasons. For one, you take EXTREME liberties with "better off" attribution for things NOT ATTRIBUTABLE TO MONETARY INFLATION; things like efficiency and technological improvements, which, it can be argued, might otherwise have been greatly INCREASED in the absence of wasteful resource misallocation and malinvestment. Ergo, we could be much WORSE OFF, because you have completely ignored the potential LOSS OF AN OTHERWISE GAIN.

Once again, you are fixated on the notion that so long as someone's "standard of living" (as YOU loosely, presumptuously and subjectively define it) remains the same, nobody is harmed in the process. That is an absolute absurdity, which brings back full circle to the point I made--which you ignored. So here it is again, to give you another opportunity to address it. You don't have to answer. You can attack the phrasing or relevance of my question--but not out of ignorance or hand-waving dismissal. At least be logical about it.

You think that if you can demonstrate a zero-sum-game, (i.e., so long as people can make substitutions, or can afford exactly the same shit), that you can then argue that they are "as well off", if not "better off" (in the context of CURRENCY DEBASEMENT and resulting PRICE INFLATION).

ONCE AGAIN: You hold stock. That stock periodically pays you dividends. I steal those dividends, intercepting them, forging your signature, and cashing those checks EVERY TIME YOU RECEIVE THEM. And let's say that you're none the wiser. You didn't even know you had a dividend coming. Furthermore, I don't touch your stock. That's yours to keep. Can I now declare with a straight face that you are "no worse off" than before, or "as well off" as before, and is there anything whatsoever even meaningful about that?

Oh, and to sweeten the pot, as we roll up our sleeves and decide things for others: What if I see you can't quite afford next year what you could last year, and "give you enough to be able to afford" yada yada yada. Would that make you "better off", if I, as a thief, did that for you?

It's a simple question. If you think it doesn't apply, or has no relevance, EXPLAIN WHY.

WTF is with your "if you give someone just enough"? You make it sound as though allowances are being doled out from some parent figure who is looking over your shoulder and approving a personal budget. What the fuck kind of Orwellian bullshit planet are you living on?

Furthermore, what you said MADE NO SENSE! How can having just enough to be able to buy next year as last year make anyone BETTER off? Explain. Is your Inflation Normalcy Bias so freakishly ingrained in you that merely keeping pace with an artificial treadmill counts AS A GAIN?! The fucking gain would be if there was no treadmill, and you actually ADVANCED.

Holy crap, what a loaded, screamingly fallacious, compound question. "...and attempt to make seniors no worse off by indexing..." WTF DOES THAT MEAN? What does that mean, first of all, and who, exactly, is trying to do whatever-that-means?

I deliberately avoided reference to that monstrously tortured scam called Social Security, and its relation to CPI. We're talking about the CPI and its accuracy or inaccuracy with regard to price inflation only, without respect to anything else. Even so, wow. Total meltdown--"...better off than the previous year, because of substitution(?!)..." is absolute gibberish! How is that true, and what, exactly, does that have to do price inflation?

Its clear, you don't understand Intro Micro Economics. Read a book about it sometime. This is simple textbook substitution. I explained it clearly and you refuse to get it. Maybe the graphs and details in a book might help you understand the most basic of economic concepts.

Stop criticizing substitution adjustments until you understand what substitution is.

Its clear, you don't understand Intro Micro Economics. Read a book about it sometime. This is simple textbook substitution. I explained it clearly and you refuse to get it. Maybe the graphs and details in a book might help you understand the most basic of economic concepts.

Stop criticizing substitution adjustments until you understand what substitution is.

You said...nothing. I have no problem with substitution effects as it relates to microeconomics -- only your misapprehension and misapplication of them. It's clear to me now that you are the one without the slightest understanding of various substitution effects, and their relevance to the CPI's ability to accurately reflect price inflation. You say, in essence, "Hey, you don't get it, so why don't go and read a textbook", sounds very Southpark Cartman bluffish to me. You didn't cite a textbook (as requested), you didn't quote from a textbook, and you couldn't even recommend a specific book (so that I could go and do your work for you). If you ever did take an ME course (intro or otherwise), I seriously doubt that you paid attention.

4% would be better for a variety of reasons. Sticky wages, debt deflation and monetary policy flexibility near the zero lower bound.

What do sticky wages have to do with the inflation target? They would only be important if you tried to change the current target, according to neo-classical / new-keynesian belief. As long as the inflation rate is as expected, the absolut rate doesn't matter. And if it did, why not 20%? Or 100%?

Also, how does a higher inflation rate cause debt deflation, but not savings deflation at the same time? Earlier you argued that the store of people's value is not affected by monetary inflation, because people could simply invest in the loanable funds market in one way or another. Obviously the return of those investments will be denominated in the currency and thus be lower than it would have been otherwise - exactly by the amount of inflation. That doesn't mean that you have lower purchasing power tomorrow than you have today, but that tomorrow's purchasing power is lower than it would have been, had there not been inflation. Or you could argue that expected inflation is already somehow included in your investment-return - in which case the same would hold true for debt, too. In any way, it shows a lack of economic understanding to argue that debt-inflation should be a goal we ought to achieve. If the value of the money the borrower has to pay back is lower, it's at the same time also lower for the saver. Why would that be considered to be beneficiary, especially considering that most savers are retirees whose main source of income are capital returns?

But the last point about monetary policy flexibility has to be the worst argument in favour of higher inflation, on a libertarian board, where people can see the problems of the Keynesian paradigm of aggregated anything. People who studied economics carefully know how devastating the manipulation of interest rates is to the capital structure of an economy. Currently the Fed is somehow limited, because it can't drop nominal interest rates below zero. With an inflation rate of 2% the lower boundary of the real interest rate would be -2%. Would the interest rate target be higher, the Fed could decrease real interest rates even further - and that's what you want to have?

You must be aware of the fact, that the price brings demand and supply in equilibrium. If the price for lending money (the interest rate) goes down due to newly created money supply by the Fed, private savings are going to go down, relative to consumption (which goes up). At the same time investment goes up, because it's cheaper to borrow money. While without interventions from the central bank a decreasing interest rate would actually be a good sign for entrepreneurs to invest (because higher savings indicate more demand for consumptions goods in the future), there are no savings in our economy, justifying the increase in investment. At the same time companies in the early stages of production bid for workers and commodities, retailers have the time of their lifes, because of the increased consumption (due to a lower saving rate). This causes the overall prices to rise - which can only be "fought" by the central bank by even more monetary inflation. This unsustainable cycle will continue until either a recession ends the scheme, when the investments finally result in consumption goods, but nobody has any money to actually purchase all the goods. This causes a liquidation of debt and reallocation of malinvestments. Or the central bank continues what it does and causes a hyperinflation.

You said...nothing. I have no problem with substitution effects as it relates to microeconomics -- only your misapprehension and misapplication of them. It's clear to me now that you are the one without the slightest understanding of various substitution effects, and their relevance to the CPI's ability to accurately reflect price inflation. You say, in essence, "Hey, you don't get it, so why don't go and read a textbook", sounds very Southpark Cartman bluffish to me. You didn't cite a textbook (as requested), you didn't quote from a textbook, and you couldn't even recommend a specific book (so that I could go and do your work for you). If you ever did take an ME course (intro or otherwise), I seriously doubt that you paid attention.

LOL, I taught Micro for three years and have a graduate degree kid. Varian is the standard book. I'm using basic English.

Like wow, you balk at the phrase "relative prices", like its some kind of voodoo. Just use the dictionary for the word relative, it will help.

What do sticky wages have to do with the inflation target? They would only be important if you tried to change the current target, according to neo-classical / new-keynesian belief. As long as the inflation rate is as expected, the absolut rate doesn't matter. And if it did, why not 20%? Or 100%?

Also, how does a higher inflation rate cause debt deflation, but not savings deflation at the same time? Earlier you argued that the store of people's value is not affected by monetary inflation, because people could simply invest in the loanable funds market in one way or another. Obviously the return of those investments will be denominated in the currency and thus be lower than it would have been otherwise - exactly by the amount of inflation. That doesn't mean that you have lower purchasing power tomorrow than you have today, but that tomorrow's purchasing power is lower than it would have been, had there not been inflation. Or you could argue that expected inflation is already somehow included in your investment-return - in which case the same would hold true for debt, too. In any way, it shows a lack of economic understanding to argue that debt-inflation should be a goal we ought to achieve. If the value of the money the borrower has to pay back is lower, it's at the same time also lower for the saver. Why would that be considered to be beneficiary, especially considering that most savers are retirees whose main source of income are capital returns?

But the last point about monetary policy flexibility has to be the worst argument in favour of higher inflation, on a libertarian board, where people can see the problems of the Keynesian paradigm of aggregated anything. People who studied economics carefully know how devastating the manipulation of interest rates is to the capital structure of an economy. Currently the Fed is somehow limited, because it can't drop nominal interest rates below zero. With an inflation rate of 2% the lower boundary of the real interest rate would be -2%. Would the interest rate target be higher, the Fed could decrease real interest rates even further - and that's what you want to have?

You must be aware of the fact, that the price brings demand and supply in equilibrium. If the price for lending money (the interest rate) goes down due to newly created money supply by the Fed, private savings are going to go down, relative to consumption (which goes up). At the same time investment goes up, because it's cheaper to borrow money. While without interventions from the central bank a decreasing interest rate would actually be a good sign for entrepreneurs to invest (because higher savings indicate more demand for consumptions goods in the future), there are no savings in our economy, justifying the increase in investment. At the same time companies in the early stages of production bid for workers and commodities, retailers have the time of their lifes, because of the increased consumption (due to a lower saving rate). This causes the overall prices to rise - which can only be "fought" by the central bank by even more monetary inflation. This unsustainable cycle will continue until either a recession ends the scheme, when the investments finally result in consumption goods, but nobody has any money to actually purchase all the goods. This causes a liquidation of debt and reallocation of malinvestments. Or the central bank continues what it does and causes a hyperinflation.

The sticky wages story is about psychology. People have difficulty dealing with cuts in their nominal wages. That means if there inflation of 4 percent and the optimal real wage change is -3% in real terms, the employer can just say "Your pay raise this year is 1%" and most employees will be happy because they don't think in real terms. However, if the inflation rate is 2%, the employer can't make the full adjustment necessary. They can say that the wage change is 0%, and decrease real wages by 2%, but not the full three. As inflation goes to zero, they have even less flexibility. Why is it bad that the employer can't decrease someone's real wages? Well if wages are higher than they should be, it means more people are going to be unemployed and unable to find work. This story has some empirical backing because wage changes all "pile up" around 0%, meaning almost nobody gets nominal wage cuts.

The debt deflation point is really a one time fix that a higher inflation target would yield for the current situation we are in. There are a lot of people out there with nominal mortgage and other debt. Higher inflation would make it easier on them and prevent a lot of defaults. This probably isn't true, but one could imagine situations where the banks even gain as well as homeowners because the higher inflation reduces defaults of underwater borrowers. My perspective on it, is that it would be good to reduce the deadweight losses of foreclosure and default.

On the third point, I disagree with the consensus on the board and have been arguing against it. I think the Fed moving interest rates can be good and more flexibility during recessions would be better.

On the last point, your explanation is a little off I think. The interest rates the Fed sets are equilibrium interest rates, they clear all markets and there is no excess supply or demand of savings or borrowing (As there would be in a classic price floor or ceiling). This is precisely because they move interest rates by changing the money supply and demand for money depends partially on interest rates. In your supply/demand example, they move the price by shifting the supply curve, not by creating a ceiling or floor.

The sticky wages story is about psychology. People have difficulty dealing with cuts in their nominal wages. That means if there inflation of 4 percent and the optimal real wage change is -3% in real terms, the employer can just say "Your pay raise this year is 1%" and most employees will be happy because they don't think in real terms. However, if the inflation rate is 2%, the employer can't make the full adjustment necessary. They can say that the wage change is 0%, and decrease real wages by 2%, but not the full three. As inflation goes to zero, they have even less flexibility. Why is it bad that the employer can't decrease someone's real wages? Well if wages are higher than they should be, it means more people are going to be unemployed and unable to find work. This story has some empirical backing because wage changes all "pile up" around 0%, meaning almost nobody gets nominal wage cuts.

I know about sticky wage theory and it's supposed effect, but I don't buy it entirely. First of all, the major reason why they exist to some extend in the first place, is because of governmental intervention in the labor market, special privileges for unions, etc. In a free market, inefficient behaviour of wage earners will put them out of business and people will learn that a 2% nominal wage cut is better than a 100% real wage cut if the firm goes out of business. Besides, why aren't wages sticky in both directions? You could also argue that with high inflation, businesses are going to increase wages at a lower rate than inflation, because workers will be satisfied with a 2-3% increase, even if inflation is at 10%, because they are to stupid to realize what real wages are. Thus creating the same inefficiency the other way around.

The debt deflation point is really a one time fix that a higher inflation target would yield for the current situation we are in. There are a lot of people out there with nominal mortgage and other debt. Higher inflation would make it easier on them and prevent a lot of defaults. This probably isn't true, but one could imagine situations where the banks even gain as well as homeowners because the higher inflation reduces defaults of underwater borrowers. My perspective on it, is that it would be good to reduce the deadweight losses of foreclosure and default.

First of all, the foreclosure and default argument is a mood point. If it is indeed better for banks to lower the debt of it's debtors, then they don't need price inflation for it. They could simply offer a "haircut".

Don't say that savers are not going to be hurt under higher price inflation if you make the point that the return will be devalued, thus helping debters. You can't have it both ways. It's a zero-sum game.

On the third point, I disagree with the consensus on the board and have been arguing against it. I think the Fed moving interest rates can be good and more flexibility during recessions would be better.

Of course you could delay recessions by increasing the money supply. Nobody says that this won't increase total output. In fact, that's a core assumption of the Austrian Business Cycle Theory. But you don't see recessions as what they are. A necessary evil to reallocate badly allocated ressources (most times because of bad monetary policy in the past). You're not doing society a big favour if you artificially stimulate the economy to continue in an inefficient way. In fact the same problem will come back later, only larger this time. History shows that those recessions that got the most political response have been the most severe and long lasting ones, while those where the economy was "left alone" restructured very quickly, even though the initial shock was just as hard. And that's not that hard to understand, once you realize what a recession really is. Of course if you blame everything on "animal spirits" rather than on systemic reasons, you won't be able to draw many conclusions out of it.

On the last point, your explanation is a little off I think. The interest rates the Fed sets are equilibrium interest rates, they clear all markets and there is no excess supply or demand of savings or borrowing (As there would be in a classic price floor or ceiling). This is precisely because they move interest rates by changing the money supply and demand for money depends partially on interest rates. In your supply/demand example, they move the price by shifting the supply curve, not by creating a ceiling or floor.

That's exactly what I've said. I did point out that the Feds actions represent a shift in the money supply curve. Maybe what confused you was my point about the liquidity trap situation you mentioned earlier?

Again, in a free market people save (and let's for the sake of the argument assume that savings=lendings=investments) and people borrow. When people suddenly decide to save more (higher savings rate represents a shift in the money supply to the right on the loanable funds market) more money at a lower price is being lent out, if the money demand curve remains unchanged (ceteris paribus).

What happens in the economy? Well, borrowers are taking that additional money in order to built capital goods so that they can increase their production in the future. The savers on the other hand are going to spend less today. Why? Because they save more. They can't use money twice. Y=C+I

Now Keynes would have (wrongly) argued that this situation would result in a recession. His reasoning was that if consumption goes down now, nobody is going to invest in the future (paradox of swift). That argument is really bad on a number of grounds. First of all, yes, retailers had to lay of workers if consumption goes down, no question about that. But the problem of Keynesian/neo-classical economics is that in those schools of thought Y equals Y equals Y... and K equals K equals K.

Just because some people lose their jobs and the economy restructers a little bit, doesn't necessarily mean that it's a bad thing. Also, the firms who want to borrow the higher amount of capital at lower interest rates, are certainly not retailers. They are companies in mining, housing, R&D, etc. with long term strategies at the earliest stages of production. These entrepreneurs are perfectly able to understand that low costs of borrowing money are great for them and that the demand for their product is not going to be affected by the current lower demand for consumption goods, because their goods are going to enter the shelves in 10, 20 or 30 years. And they also know that there has to be demand in the future, since they borrowed money from others who are going to want to consume eventually. Nobody invests for the sake of investing. In the end, for every salesman laid of, a miner or researcher is going to be employed.

So we see that in an unhampered market, the path to sustainable growth in the future is to save today. And that's perfectly sustainable because the payback of borrowed money with interest represents excess demand later, exactly at the time the exess supply of goods is occuring.

Now what happens if the central bank increases the money supply, not private savers? Again, the supply curve of loanable funds shifts to the right, but the amount of money that is actually being saved by market actors is still where it was before. The excess money does not represent savings.

How could that be? Because what the newly created money does is syphoning purchasing power from all currency holders. In a perfectly adjusting economy prices would rise instantaneously across the board, if the money supply where to be increased evenly. Since that new money mostly goes to the government via bonds it would in effect be equal to a lump sum tax.

But the economy is not perfectly adjusting and we do not have perfect information. Lenders are suddenly confronted with a lower interest rate, thus fewer people are going to save today and thus current consumption is going to go up (as opposed to the situation where lower consumption resulted in lower interest rates, because of higher savings). At the same time borrowers are confronted with lower interest rates too, which will result in a higher amount of investment. So I and C are both trying to increase at the same time. But since resources are scarce, this will result in prices being bid up - but not instantaneously, it will take time (Friedman's famous "time lag" he couldn't really figure out). For a short amount of time we will see zero unemployment (or rates below the natural rate, because of excess work force wanting to work in the boom economy) and higher total output. Everything seems to be great until inflation finaly kicks in and increases the prices of goods. To combat this the central bank increases the money supply again year after year, only delaying the inevitable. Eventually those investments will result in even more goods being produced. But (as opposed to the free market growth situation) there is no excess demand (desire and ability to purchase at prices X).

In no situation can a central bank know better what an economy needs than the actions of millions of individuals responding to other individuals' actions displayed by prices, profits and losses.

I know about sticky wage theory and it's supposed effect, but I don't buy it entirely. First of all, the major reason why they exist to some extend in the first place, is because of governmental intervention in the labor market, special privileges for unions, etc. In a free market, inefficient behaviour of wage earners will put them out of business and people will learn that a 2% nominal wage cut is better than a 100% real wage cut if the firm goes out of business. Besides, why aren't wages sticky in both directions? You could also argue that with high inflation, businesses are going to increase wages at a lower rate than inflation, because workers will be satisfied with a 2-3% increase, even if inflation is at 10%, because they are to stupid to realize what real wages are. Thus creating the same inefficiency the other way around.

First of all, the foreclosure and default argument is a mood point. If it is indeed better for banks to lower the debt of it's debtors, then they don't need price inflation for it. They could simply offer a "haircut".

Don't say that savers are not going to be hurt under higher price inflation if you make the point that the return will be devalued, thus helping debters. You can't have it both ways. It's a zero-sum game.

Of course you could delay recessions by increasing the money supply. Nobody says that this won't increase total output. In fact, that's a core assumption of the Austrian Business Cycle Theory. But you don't see recessions as what they are. A necessary evil to reallocate badly allocated ressources (most times because of bad monetary policy in the past). You're not doing society a big favour if you artificially stimulate the economy to continue in an inefficient way. In fact the same problem will come back later, only larger this time. History shows that those recessions that got the most political response have been the most severe and long lasting ones, while those where the economy was "left alone" restructured very quickly, even though the initial shock was just as hard. And that's not that hard to understand, once you realize what a recession really is. Of course if you blame everything on "animal spirits" rather than on systemic reasons, you won't be able to draw many conclusions out of it.

That's exactly what I've said. I did point out that the Feds actions represent a shift in the money supply curve. Maybe what confused you was my point about the liquidity trap situation you mentioned earlier?

Again, in a free market people save (and let's for the sake of the argument assume that savings=lendings=investments) and people borrow. When people suddenly decide to save more (higher savings rate represents a shift in the money supply to the right on the loanable funds market) more money at a lower price is being lent out, if the money demand curve remains unchanged (ceteris paribus).

What happens in the economy? Well, borrowers are taking that additional money in order to built capital goods so that they can increase their production in the future. The savers on the other hand are going to spend less today. Why? Because they save more. They can't use money twice. Y=C+I

Now Keynes would have (wrongly) argued that this situation would result in a recession. His reasoning was that if consumption goes down now, nobody is going to invest in the future (paradox of swift). That argument is really bad on a number of grounds. First of all, yes, retailers had to lay of workers if consumption goes down, no question about that. But the problem of Keynesian/neo-classical economics is that in those schools of thought Y equals Y equals Y... and K equals K equals K.

Just because some people lose their jobs and the economy restructers a little bit, doesn't necessarily mean that it's a bad thing. Also, the firms who want to borrow the higher amount of capital at lower interest rates, are certainly not retailers. They are companies in mining, housing, R&D, etc. with long term strategies at the earliest stages of production. These entrepreneurs are perfectly able to understand that low costs of borrowing money are great for them and that the demand for their product is not going to be affected by the current lower demand for consumption goods, because their goods are going to enter the shelves in 10, 20 or 30 years. And they also know that there has to be demand in the future, since they borrowed money from others who are going to want to consume eventually. Nobody invests for the sake of investing. In the end, for every salesman laid of, a miner or researcher is going to be employed.

So we see that in an unhampered market, the path to sustainable growth in the future is to save today. And that's perfectly sustainable because the payback of borrowed money with interest represents excess demand later, exactly at the time the exess supply of goods is occuring.

Now what happens if the central bank increases the money supply, not private savers? Again, the supply curve of loanable funds shifts to the right, but the amount of money that is actually being saved by market actors is still where it was before. The excess money does not represent savings.

How could that be? Because what the newly created money does is syphoning purchasing power from all currency holders. In a perfectly adjusting economy prices would rise instantaneously across the board, if the money supply where to be increased evenly. Since that new money mostly goes to the government via bonds it would in effect be equal to a lump sum tax.

But the economy is not perfectly adjusting and we do not have perfect information. Lenders are suddenly confronted with a lower interest rate, thus fewer people are going to save today and thus current consumption is going to go up (as opposed to the situation where lower consumption resulted in lower interest rates, because of higher savings). At the same time borrowers are confronted with lower interest rates too, which will result in a higher amount of investment. So I and C are both trying to increase at the same time. But since resources are scarce, this will result in prices being bid up - but not instantaneously, it will take time (Friedman's famous "time lag" he couldn't really figure out). For a short amount of time we will see zero unemployment (or rates below the natural rate, because of excess work force wanting to work in the boom economy) and higher total output. Everything seems to be great until inflation finaly kicks in and increases the prices of goods. To combat this the central bank increases the money supply again year after year, only delaying the inevitable. Eventually those investments will result in even more goods being produced. But (as opposed to the free market growth situation) there is no excess demand (desire and ability to purchase at prices X).

In no situation can a central bank know better what an economy needs than the actions of millions of individuals responding to other individuals' actions displayed by prices, profits and losses.

On the sticky wage theory, I'm not making any assumption about what employers and employees should do, its just an empirical fact that wage changes all pile up around zero, with very few nominal wage cuts. It could very well be that the firms that cut nominal wages are the ones that go out of business. Some people think workers become much less productive and sort of go on a mini strike when they get a nominal wage cut. Imagine you were an employee looking at two identical firms except one is known for nominal wage cuts and the other isn't. Its not clear why the wage cutter would have an advantage. In other words, the free market equilibrium, given all the constraints about how people think, could very well be the one with no cuts to nominal wages. I think its a common misconception that the free market is always optimal. Sometimes the free market sucks. Many of these times the government sucks worse, but that doesn't mean we should assume the free market leads to perfection. There is no inherent reason why the free market should achieve all of the goals we value. There are proofs that it gets close to pareto efficient outcomes, but that isn't the only thing we care about.

On the default point, I think that is wrong. The banks don't want to be seen as the bank that will voluntarily write down your debt whenever you have trouble paying. When they get that reputation, everyone will just stop paying until they write down the debt over and over. And my main idea was that it would make borrowers much better off and banks only a little worse off, so there would be some net gains. That's why I said banks being made better off was unlikely.

I don't agree with your empirical assessment of recessions. I think the evidence is slightly in favor of fiscal stimulus being a net positive for economies, although there is a lot of difficulty establishing causality. Here is the main problem: the recessions where governments get involved the most are the worst, precisely because governments feel the need to get involved more when things get worse. The question is whether we can disentangle the impact of the government intervention from the recession itself. This is almost impossible, but the good work that has been done shows positive impacts of fiscal stimulus and tax cuts during recessions around the world. You do this by comparing countries in a similar situation before stimulus, one of which does fiscal stimulus and the other doesn't. Still not anywhere close to perfect, but getting better. Anyway, if you want to argue this point, you need better evidence than simply more government involvement means worse recession.

I don't understand why we need unemployment in order to go through a restructuring and why restructurings can't take place all the time, in recessions and out. I view unemployment as a market failure due to an artificial price ceiling on wages. Real wages can't adjust down quickly because they are sticky, so labor supply outpaces labor demand, resulting in unemployment. This is a huge loss for the economy because there are a bunch of people sitting around that would love to work, that can't find jobs. Why do these people have to sit around without work in order for a restructuring to take place?

I think I agree with everything in your longer explanation except the inevitability of the recession. We agree the monetary stimulus gives us a short term boom. Why does this eventually have to result in a recession? Ie why does output have to go below the point where it would have been without the monetary stimulus?

On the sticky wage theory...its just an empirical fact that wage changes all pile up around zero, with very few nominal wage cuts.

It is well that you said, "On the sticky wage theory...its just an empirical fact that...", because they're two different things entirely. It's like saying "On the phlogiston theory, it's just an empirical fact that things combust and burn when they get hot." Unfortunately for the phlogiston theorists (and the world that had to suffer them), burning and combustion could not be derived from, and have nothing whatsoever to do with, the now fully debunked phlogiston theory.

The whole theory sticky wages and prices (wages ARE prices) cannot be derived from first principles or optimization. So the phenomenon you called sticky wages--whatever it is--is NOT universal, and can only be empirically observed, with little to no bearing on the mechanics of the theory going by that name--to the point where most mainstream economists are abandoning the theory altogether (much to Phlogistonist Krugman's chagrin, and my delight).

The sticky wages concept, along with the "liquidity trap", was spawned as a theoretical boogeyman hypothesis, as a post-hoc rationale for the very regime we are now living under. The theory was that if we kept inflating the currency, the boogeyman of sticky wages (nominal rigidity in an environment of other falling prices) would no longer be the bane of a healthy economy. What few sticky-wagists like to consider is that in an inflationary environment (which we are most definitely in, regardless how it gets minimized or marginalized), zero downward nominal wage changes are the equivalent of wage cuts in relative wages. We're not in a Keynes-less world, and yet many nominal wages ARE falling, throughout the economy. And the nominal wages that are not being cut are relative wages that ARE falling as well!

In a perfectly competitive labor market, a Mexican Standoff interdependency exists, whereby both the firm and the employee have invested time and money into making the employee fit for a very specific kind of productivity. It is not like the firm can go down the street and get something slightly cheaper and save a few pennies. If an employee refuses to take a small nominal pay cut, the firm must factor in a cost of replacement, and all that entails, which is often substantial.

It could very well be that the firms that cut nominal wages are the ones that go out of business.

Yeah, and it could very well be that the employees who refuse to have their nominal wages cut are only doing so because THEY would lose their solvency, and "go out of business". That bring up another side of the Keynesian aggregate demand model insanity, and the monetarist policies that were spawned from it. It has made it so that most people have no savings, are fully leveraged, in debt up to their eyeballs, and living only to service all their debts, public and private. If you want to find NOMINAL RIGIDITY, FOLLOW THE DEBT. Furthermore, to see what is eroding their equity in their labors, don't just follow a basket of private goods. Follow the heavy haystack of public revenue expectation straw that are heaped on that camel's back everywhere it turns. The public sector "prices" RARELY FALL, and will seek its pound of flesh regardless. So the average laborer with no increase in nominal wages is already losing money at an accelerated rate, and may not see any benefit at all from any increased productivity.

The banks don't want to be seen as the bank that will voluntarily write down your debt whenever you have trouble paying. When they get that reputation, everyone will just stop paying until they write down the debt over and over.

Bullshit. It has nothing to do with reputation. This is not Carlito's Way, with a mafioso who doesn't want the word out on the street that he's going soft. Banks are all business, and write down debts all the time, but only when they LOSE LEVERAGE, and never when there are alternatives, as when there is legal or equity blood still left in the turnip. That happens all the time, and even if it resulted in "a reputation", the issue of "stop paying until they write down the debt" is gross naivete, because there are extreme risks and ramifications for individuals (READ=LEVERAGE BY THE BANK) for that, as property can be seized, accounts levied, credit ratings go in the tank, and so forth.

I think the evidence is slightly in favor of fiscal stimulus being a net positive for economies, although there is a lot of difficulty establishing causality.

Whose economies? If two people make up an island economy, and one person enslaves the other and steals all his wealth, that might actually be "net positive for the economy". Because macro-economics is deliberately retarded in its capacity for granularity, there is no way to know if anything was "net positive" (whatever "positive" means) for individual economies. But the difficulty is even worse than that, because at no point do you have a parallel universe economy with which to compare. So you don't even have a starting point for a concept of what "net positive" means. For that you have to go into the past, and set some arbitrary zero baseline for "normal". Which is MEANINGLESS.

It is well that you said, "On the sticky wage theory...its just an empirical fact that...", because they're two different things entirely. It's like saying "On the phlogiston theory, it's just an empirical fact that things combust and burn when they get hot." Unfortunately for the phlogiston theorists (and the world that had to suffer them), burning and combustion could not be derived from, and have nothing whatsoever to do with, the now fully debunked phlogiston theory.

The whole theory sticky wages and prices (wages ARE prices) cannot be derived from first principles or optimization. So the phenomenon you called sticky wages--whatever it is--is NOT universal, and can only be empirically observed, with little to no bearing on the mechanics of the theory going by that name--to the point where most mainstream economists are abandoning the theory altogether (much to Phlogistonist Krugman's chagrin, and my delight).

The sticky wages concept, along with the "liquidity trap", was spawned as a theoretical boogeyman hypothesis, as a post-hoc rationale for the very regime we are now living under. The theory was that if we kept inflating the currency, the boogeyman of sticky wages (nominal rigidity in an environment of other falling prices) would no longer be the bane of a healthy economy. What few sticky-wagists like to consider is that in an inflationary environment (which we are most definitely in, regardless how it gets minimized or marginalized), zero downward nominal wage changes are the equivalent of wage cuts in relative wages. We're not in a Keynes-less world, and yet many nominal wages ARE falling, throughout the economy. And the nominal wages that are not being cut are relative wages that ARE falling as well!

In a perfectly competitive labor market, a Mexican Standoff interdependency exists, whereby both the firm and the employee have invested time and money into making the employee fit for a very specific kind of productivity. It is not like the firm can go down the street and get something slightly cheaper and save a few pennies. If an employee refuses to take a small nominal pay cut, the firm must factor in a cost of replacement, and all that entails, which is often substantial.

Yeah, and it could very well be that the employees who refuse to have their nominal wages cut are only doing so because THEY would lose their solvency, and "go out of business". That bring up another side of the Keynesian aggregate demand model insanity, and the monetarist policies that were spawned from it. It has made it so that most people have no savings, are fully leveraged, in debt up to their eyeballs, and living only to service all their debts, public and private. If you want to find NOMINAL RIGIDITY, FOLLOW THE DEBT. Furthermore, to see what is eroding their equity in their labors, don't just follow a basket of private goods. Follow the heavy haystack of public revenue expectation straw that are heaped on that camel's back everywhere it turns. The public sector "prices" RARELY FALL, and will seek its pound of flesh regardless. So the average laborer with no increase in nominal wages is already losing money at an accelerated rate, and may not see any benefit at all from any increased productivity.

Bullshit. It has nothing to do with reputation. This is not Carlito's Way, with a mafioso who doesn't want the word out on the street that he's going soft. Banks are all business, and write down debts all the time, but only when they LOSE LEVERAGE, and never when there are alternatives, as when there is legal or equity blood still left in the turnip. That happens all the time, and even if it resulted in "a reputation", the issue of "stop paying until they write down the debt" is gross naivete, because there are extreme risks and ramifications for individuals (READ=LEVERAGE BY THE BANK) for that, as property can be seized, accounts levied, credit ratings go in the tank, and so forth.

Whose economies? If two people make up an island economy, and one person enslaves the other and steals all his wealth, that might actually be "net positive for the economy". Because macro-economics is deliberately retarded in its capacity for granularity, there is no way to know if anything was "net positive" (whatever "positive" means) for individual economies. But the difficulty is even worse than that, because at no point do you have a parallel universe economy with which to compare. So you don't even have a starting point for a concept of what "net positive" means. For that you have to go into the past, and set some arbitrary zero baseline for "normal". Which is MEANINGLESS.

You are funny. All I'm saying is that wages are sticky in our economy, that's a fact you can see in the data. The theory is about what affects this has on the economy. We can't know this perfectly because we don't observe the alternative economy where wages are perfectly flexible.The firms with sticky wages are not all going out of business because of this, so it looks like sticky wages are optimal for firms in some sense. I explained one theory why, that workers decrease productivity dramatically when the firm cuts their wages. Therefore, the firms that cut nominal wages have big productivity declines and go out of business. This would happen in a perfectly free market.

Don't care about why the theory was invented, all I care about is whether its true or not and whats its implications are.

Seriously, your response to the bank thing is just absurd. If a bank sets a policy that it will always write down your debt, more people will stop paying their debt, its obvious. This is as simple as people respond to incentives, not sure why you are denying that LOL.

Well, most people here claim that government spending doesn't even increase GDP, so I'll correct that first and we can worry and the distributional effects later.

On the sticky wage theory, I'm not making any assumption about what employers and employees should do, its just an empirical fact that wage changes all pile up around zero, with very few nominal wage cuts. It could very well be that the firms that cut nominal wages are the ones that go out of business. Some people think workers become much less productive and sort of go on a mini strike when they get a nominal wage cut. Imagine you were an employee looking at two identical firms except one is known for nominal wage cuts and the other isn't. Its not clear why the wage cutter would have an advantage. In other words, the free market equilibrium, given all the constraints about how people think, could very well be the one with no cuts to nominal wages. I think its a common misconception that the free market is always optimal. Sometimes the free market sucks. Many of these times the government sucks worse, but that doesn't mean we should assume the free market leads to perfection. There is no inherent reason why the free market should achieve all of the goals we value. There are proofs that it gets close to pareto efficient outcomes, but that isn't the only thing we care about.

Pareto efficient outcomes are the only thing I care about, if it comes to policy. If you can make at least someone better of, without making anyone worse off, go for it. That should be the only rule for policy-makers to determine policies. But the free market is way superior in reaching these states (the only thing preventing perfection would obviously be transaction costs - see Coase theorem).

Again, why would you prefer 4% inflation and not 10%? Wouldn't that give employers even more room for their bargaining?

On the default point, I think that is wrong. The banks don't want to be seen as the bank that will voluntarily write down your debt whenever you have trouble paying. When they get that reputation, everyone will just stop paying until they write down the debt over and over. And my main idea was that it would make borrowers much better off and banks only a little worse off, so there would be some net gains. That's why I said banks being made better off was unlikely.

Who cares about the banks? Banks are not savers, they are intermediaries. Their profit comes from the differential between interest rates for savings and credit. What I care about are the real savers, individuals who invest their capital in order to consume more in the future. Every percentage point of inflation that lowers the real burden of borrowers also lowers the real return of savers by the same amount.

I don't agree with your empirical assessment of recessions. I think the evidence is slightly in favor of fiscal stimulus being a net positive for economies, although there is a lot of difficulty establishing causality. Here is the main problem: the recessions where governments get involved the most are the worst, precisely because governments feel the need to get involved more when things get worse. The question is whether we can disentangle the impact of the government intervention from the recession itself. This is almost impossible, but the good work that has been done shows positive impacts of fiscal stimulus and tax cuts during recessions around the world. You do this by comparing countries in a similar situation before stimulus, one of which does fiscal stimulus and the other doesn't. Still not anywhere close to perfect, but getting better. Anyway, if you want to argue this point, you need better evidence than simply more government involvement means worse recession.

Most empirical studies are fundamentally flawed and I don't know a "scientific" field that deserves this label less than Econometrics. Or to cite the Hayek vs. Keynes-Rap, "Oh econometricians, they're ever so pious! Are they doing real science or just confirming their bias?"

Obviously, Y goes up if you throw out the New Deal or engage your country in a War. But what has that to do with anything? As I said, Y is Y is Y is Y...
But it's not. It matters if your economy produces what people voluntarily chose, or if it produces what the government orders it to. The GDP is a imperfect measurement for "overall good" even without government spending. But with it, it becomes useless. According to your technique the Soviet Union was an economic power house throughout it's existence. Just look at those output numbers! And exactly that blind spot of mainstream economists led Samualson to praise the USSR and to predict that it's going to outperform the US even a few years before its collapse. The fact that the USSR makes econometrics look completely stupid does surprisingly little to its reputation as a scientifc field. The Russians were simply liars, their numbers can not be trusted. As opposed to all other governments' numbers, obviously.

Also, it's not that hard to have low unemployment figures if there is a draft. Real standard of living was aweful during the whole FDR presidency, there was food and gas rationing. But according to Keynesians the standard of living was going up during the New Deal era. Ask anyone alive during that period if he felt that way. The real private sector recovery occured after government spending was slashed after WW2, as can be shown by looking private sector spending.

Also, there are stunning statistical errors in almost every empirical study of the Great Depression, but nobody seems to care. As long as they confirm their bias it's alright to be unscientific.

I don't understand why we need unemployment in order to go through a restructuring and why restructurings can't take place all the time, in recessions and out. I view unemployment as a market failure due to an artificial price ceiling on wages. Real wages can't adjust down quickly because they are sticky, so labor supply outpaces labor demand, resulting in unemployment. This is a huge loss for the economy because there are a bunch of people sitting around that would love to work, that can't find jobs. Why do these people have to sit around without work in order for a restructuring to take place?

I think I agree with everything in your longer explanation except the inevitability of the recession. We agree the monetary stimulus gives us a short term boom. Why does this eventually have to result in a recession? Ie why does output have to go below the point where it would have been without the monetary stimulus?

Recessions occur if there is large-scale malinvestment. Mises describes an architect who draws a plan for a house, knowing how many bricks he has. But because someone is fudging the numbers he believes to have way more bricks than he actually has. It takes a long time to make the plan, and even during the early stages of construction, nobody realizes the mistake. But the higher the walls get, the more abundand it gets, that the amount of remaining bricks will not be sufficient to finish production. And now people will have to tear all the walls down in order to start all over again, building a smaller house. Obviously that's costly and painful.

If there is large-scale malinvestment many people are working in areas where they shouldn't be working, according to the real preferences of individuals. And since in reality K is not K is not K and L is not L is not L, it takes time to build new capital goods and factories in order to provide for labor while the unprofitable firms are being shut down or have to scale back. And even when that's done it requires time for workers to learn new skills and to realize that what they did up to this point has become useless.

Also, you would have a huge deal less unemployment during recessions without minmum wage laws, labor regulations, unions, etc.

The reason why the recession has to occur is, as I've already pointed out, because the increase in investment is not the result of higher savings, like in the free market example, but of artificially low interest rates, that actually reduce private savings. So when the investments are realized, after 10, 20 or 30 years, there is no excess demand available, to buy all those products. These investments should have never been made and they emobody labor and resources that should have been used otherwise (malinvestments). All the additonal goods that are produced now can't be bought. So Austrians even agree with Keynes that a lack of aggregate demand occurs. But this lack of demand is not the root of the problem, caused by uncontrollable, evil spirits. It is itself an effect of systemic errors.

What would happen at this point is that prices of most goods had to fall, if the firms want to get rid of their stuff, thus obviously creating price deflation. But with those lower revenues, many firms have to go out of business, some have to lay off some workers and all of them would have trouble to pay back their debt. Which also means that there is an extremely large amount of debt that has to be wiped off the books, creating further problems.

All of those conclusions can be deduced from a few simple assumptions about our economy and they seem to explain recessions and depressions really well. The Austrian Business Cycle Theory also explains why a lack of aggregate demand is occuring before things start to feel bad and fundamental data shows a decline in output. But Austrians also realize that the real systemic damage has been done during the boom, where capital was wrongly allocated, not during the bust.

All I'm saying is that wages are sticky in our economy...Don't care about why the theory was invented, all I care about is whether its true or not and whats its implications are.

Yeah, join an old club that is now chock full of Keynesian defectors. I think it is safe to say that you aren't engaging in this exercise out of pure intellectual, scientific curiosity-in-a-vacuum. Between us, you and only you are in social engineering and central planning mode at all times. There are motivational (normative) underpinnings to everything you say and believe. I'm not rolling up my sleeves with you to see what statist, monetarist bullshit can be derived from anything.

Seriously, your response to the bank thing is just absurd. If a bank sets a policy that it will always write down your debt...

Where did "a policy that it will always write down your debt" ever once enter into the discussion? Where did that bizarre straw man come from? We are talking about reality, not fictional policies that are universally applied to everyone. You're the one who implied--disingenuously--that if a bank wrote down a debt, if word got out its "reputation" for that precedent would somehow be tantamount to a SET POLICY. You need to shake the cobwebs from that aggregate-thinking brain of yours for a second, and apply some critical real-world thought. If I set a policy that I will always sell iPads for $1, the public's response will be predictable, as I'll have a demand line stretching out across the country. If, however, I offer iPads to a lucky few for $1, and word gets out (ooooohhhhh! ahhhhhh!), that same line can form all it wants, and stretch out to infinity. They can all kiss my ass. See how that works?

Well, most people here claim that government spending doesn't even increase GDP, so I'll correct that first and we can worry and the distributional effects later.

They do, huh? I haven't seen that, but thanks for the red herring, as that's not me. Since that moronic collectivist abstraction called GDP INCLUDES GOVERNMENT redistribution of wealth in the private sector, making those that are solely dependent on government spending an extension of that government, it would be kind of absurd to say that government spending doesn't increase government, wouldn't it?

Pareto efficient outcomes are the only thing I care about, if it comes to policy. If you can make at least someone better of, without making anyone worse off, go for it. That should be the only rule for policy-makers to determine policies. But the free market is way superior in reaching these states (the only thing preventing perfection would obviously be transaction costs - see Coase theorem).

Again, why would you prefer 4% inflation and not 10%? Wouldn't that give employers even more room for their bargaining?

Who cares about the banks? Banks are not savers, they are intermediaries. Their profit comes from the differential between interest rates for savings and credit. What I care about are the real savers, individuals who invest their capital in order to consume more in the future. Every percentage point of inflation that lowers the real burden of borrowers also lowers the real return of savers by the same amount.

Most empirical studies are fundamentally flawed and I don't know a "scientific" field that deserves this label less than Econometrics. Or to cite the Hayek vs. Keynes-Rap, "Oh econometricians, they're ever so pious! Are they doing real science or just confirming their bias?"

Obviously, Y goes up if you throw out the New Deal or engage your country in a War. But what has that to do with anything? As I said, Y is Y is Y is Y...
But it's not. It matters if your economy produces what people voluntarily chose, or if it produces what the government orders it to. The GDP is a imperfect measurement for "overall good" even without government spending. But with it, it becomes useless. According to your technique the Soviet Union was an economic power house throughout it's existence. Just look at those output numbers! And exactly that blind spot of mainstream economists led Samualson to praise the USSR and to predict that it's going to outperform the US even a few years before its collapse. The fact that the USSR makes econometrics look completely stupid does surprisingly little to its reputation as a scientifc field. The Russians were simply liars, their numbers can not be trusted. As opposed to all other governments' numbers, obviously.

Also, it's not that hard to have low unemployment figures if there is a draft. Real standard of living was aweful during the whole FDR presidency, there was food and gas rationing. But according to Keynesians the standard of living was going up during the New Deal era. Ask anyone alive during that period if he felt that way. The real private sector recovery occured after government spending was slashed after WW2, as can be shown by looking private sector spending.

Also, there are stunning statistical errors in almost every empirical study of the Great Depression, but nobody seems to care. As long as they confirm their bias it's alright to be unscientific.

Recessions occur if there is large-scale malinvestment. Mises describes an architect who draws a plan for a house, knowing how many bricks he has. But because someone is fudging the numbers he believes to have way more bricks than he actually has. It takes a long time to make the plan, and even during the early stages of construction, nobody realizes the mistake. But the higher the walls get, the more abundand it gets, that the amount of remaining bricks will not be sufficient to finish production. And now people will have to tear all the walls down in order to start all over again, building a smaller house. Obviously that's costly and painful.

If there is large-scale malinvestment many people are working in areas where they shouldn't be working, according to the real preferences of individuals. And since in reality K is not K is not K and L is not L is not L, it takes time to build new capital goods and factories in order to provide for labor while the unprofitable firms are being shut down or have to scale back. And even when that's done it requires time for workers to learn new skills and to realize that what they did up to this point has become useless.

Also, you would have a huge deal less unemployment during recessions without minmum wage laws, labor regulations, unions, etc.

The reason why the recession has to occur is, as I've already pointed out, because the increase in investment is not the result of higher savings, like in the free market example, but of artificially low interest rates, that actually reduce private savings. So when the investments are realized, after 10, 20 or 30 years, there is no excess demand available, to buy all those products. These investments should have never been made and they emobody labor and resources that should have been used otherwise (malinvestments). All the additonal goods that are produced now can't be bought. So Austrians even agree with Keynes that a lack of aggregate demand occurs. But this lack of demand is not the root of the problem, caused by uncontrollable, evil spirits. It is itself an effect of systemic errors.

What would happen at this point is that prices of most goods had to fall, if the firms want to get rid of their stuff, thus obviously creating price deflation. But with those lower revenues, many firms have to go out of business, some have to lay off some workers and all of them would have trouble to pay back their debt. Which also means that there is an extremely large amount of debt that has to be wiped off the books, creating further problems.

All of those conclusions can be deduced from a few simple assumptions about our economy and they seem to explain recessions and depressions really well. The Austrian Business Cycle Theory also explains why a lack of aggregate demand is occuring before things start to feel bad and fundamental data shows a decline in output. But Austrians also realize that the real systemic damage has been done during the boom, where capital was wrongly allocated, not during the bust.

I don't care just about pareto efficiency, the distribution matters.

There are costs to inflation, and 4% is low enough that those costs are modest. The optimal level is about balancing the positives and negatives.

We care about the same people. I was arguing that modest inflation could even be a pareto improvement in a debt deflation environment. If it isn't, the borrowers are helped much less than the banks are hurt. Or, to put it in real terms, property isn't destroyed and looted by the foreclosure process and hundreds of hours aren't spent dealing with the legal battle over the property.

Lots of problems with GDP. Unfortunately GDP is correlated with what matters, which is consumption. Even the people that argue that production is the important thing to think about. Everything we produce is so that eventually we can consume. GDP and consumption move so closely together. Anyway, this point is just about empirics. You made a claim that government actually makes recessions worse and longer. This is simply not true, unless you have a new measure of the severity of recessions. If you want to use GDP, consumption or unemployment, stimulus, makes all these things better.

I agree that there may be better ways to do this than spending. I don't believe in the liquidity trap and I think Scott Sumner's market monetarism will solve the problem without any need to fiscal policy. However, the statement of yours that government makes recessions worse is not actually supported by the evidence.

Ok, its not like the additional Y in C+I comes from consumption of capital, it comes from higher labor supply. Therefore, the additional investment should increase the supply of physical capital. Why does that eventually require a recession with low labor supply?

I don't like your story about aggregate demand. Here is my idea that I think will help you see where I'm coming from. Lets say we wake up tomorrow and the physical capital stock of the economy has doubled, but everything else including the number of workers stays the same. What happens over time in this economy? Do we ever have a recession?

Yeah, join an old club that is now chock full of Keynesian defectors. I think it is safe to say that you aren't engaging in this exercise out of pure intellectual, scientific curiosity-in-a-vacuum. Between us, you and only you are in social engineering and central planning mode at all times. There are motivational (normative) underpinnings to everything you say and believe. I'm not rolling up my sleeves with you to see what statist, monetarist bullshit can be derived from anything.

Where did "a policy that it will always write down your debt" ever once enter into the discussion? Where did that bizarre straw man come from? We are talking about reality, not fictional policies that are universally applied to everyone. You're the one who implied--disingenuously--that if a bank wrote down a debt, if word got out its "reputation" for that precedent would somehow be tantamount to a SET POLICY. You need to shake the cobwebs from that aggregate-thinking brain of yours for a second, and apply some critical real-world thought. If I set a policy that I will always sell iPads for $1, the public's response will be predictable, as I'll have a demand line stretching out across the country. If, however, I offer iPads to a lucky few for $1, and word gets out (ooooohhhhh! ahhhhhh!), that same line can form all it wants, and stretch out to infinity. They can all kiss my ass. See how that works?

They do, huh? I haven't seen that, but thanks for the red herring, as that's not me. Since that moronic collectivist abstraction called GDP INCLUDES GOVERNMENT redistribution of wealth in the private sector, making those that are solely dependent on government spending an extension of that government, it would be kind of absurd to say that government spending doesn't increase government, wouldn't it?

I hear the argument that government spending is completely crowded out by declines in private spending literally all the time. I'm not the one not listening if you think nobody here believes that. I've heard Rand Paul do it a number of times and you could see it in any stimulus thread on this forum.

The bank thing applies if the bank just increases its write downs and still doesn't do it for everyone. It gives people a greater incentive to stop paying. These are the types of models that regulators and banks are actually using to think about the write down problem.

I'm just doing positive economics and staying away from normative in this thread, or at least trying to as much as possible. I was a libertarian when I was younger and I'm still very libertarian on foreign policy and civil liberties. However, I haven't fully formulated what I think are the correct economic policies, although I have some ideas about which are better than others. I would rather just focus on which theories better describe the world and reserve the implications for later. I think that's a better way to do economics.

I hear the argument that government spending is completely crowded out by declines in private spending literally all the time. I'm not the one not listening if you think nobody here believes that. I've heard Rand Paul do it a number of times and you could see it in any stimulus thread on this forum.

Again, thanks for the delicious red herring. It has nothing to do with what we're discussing, but both the Swede and Brit in me loves kippers with my eggs in the morning.

The bank thing applies if the bank just increases its write downs and still doesn't do it for everyone. It gives people a greater incentive to stop paying.

Yes, in Bizarro World, I'm sure. You didn't address the real world facts I called out, like all the incentives people have to continue paying, and all the disincentives that are always in place that prevent people from wanting to stop payments--even if they thought it might result in a write down. Already, the market is filled with myriad nightmare scenarios of people who even try to get a loan modification, only to find themselves caught in a bank's foreclosure trap.

I'm just doing positive economics and staying away from normative in this thread, or at least trying to as much as possible.

No, I think you're just unaware that pretty much everything you are doing is from a decidedly normative base, with normative biases. Everything about Keynesian-spawned economics has an inescapable normative foundation. There is no way to wash your hands of that -- TO WIT:

I was a libertarian when I was younger and I'm still very libertarian on foreign policy and civil liberties. However, I haven't fully formulated what I think are the correct economic policies...

See that? Right to the motives -- only a statist monetarist with a normative mindset would say such a thing, which begs the question regarding the mere existence of "correct economic policies". And for the record, I don't view a lack of economic policy in the macro as the equivalent to an economic policy. Zero is zero. The absence of a policy is not a policy.

You're in the mode of having "...some ideas about which are better than others."

I would rather just focus on which theories better describe the world and reserve the implications for later. I think that's a better way to do economics.

How convenient for you. You get to spend your time attempting to describe a whole bunch of complex normative bullshit, along with the impossibility of ever accurately describing the erstwhile effects of their absence.

If you want economics to be objective, or a real science, pareto efficiency is the only important yard stick for economic policy recommendations. Only if nobody is worse off by a policy change and least one individual better off, can you label it as "good" from a scientific point of view. By what objective are you judging distribution? Interpersonal utility comparison does not work.

We care about the same people. I was arguing that modest inflation could even be a pareto improvement in a debt deflation environment. If it isn't, the borrowers are helped much less than the banks are hurt. Or, to put it in real terms, property isn't destroyed and looted by the foreclosure process and hundreds of hours aren't spent dealing with the legal battle over the property.

No we don't care about the same people. I care about people who save and invest their money, who are hurt by higher inflation. I don't buy the theory that inflation is good because it prevents foreclosures, and if foreclosures were to occur on a large scale I wouldn't want policy makers to step in, because this sends a great signal to the economy (like, "Stop investing in effin housing already!"). Also all those mortgages and the huge amount of debt only exists precisely because the central bank interfered in the first place, because of the process I explained already in great detail.

Lots of problems with GDP. Unfortunately GDP is correlated with what matters, which is consumption. Even the people that argue that production is the important thing to think about. Everything we produce is so that eventually we can consume. GDP and consumption move so closely together. Anyway, this point is just about empirics. You made a claim that government actually makes recessions worse and longer. This is simply not true, unless you have a new measure of the severity of recessions. If you want to use GDP, consumption or unemployment, stimulus, makes all these things better.

GDP is meaningless if a huge chunk of it is government spending or in any way controlled by the government. Again, what about Soviet Russia? Was that a great economy in your book? Because it's output figures were impressive.

GDP is only a good proxy because in the free market our preferences and subjective valuations of goods and services result in prices. If we then look at total spending it gives a good clue about a society's wealth. However when the government purchases things prices have nothing to do with subjective values. It distorts the whole picture. FDR let factories build tanks and weapons while people were starving, who would have never made the same choices in a free market. But it created just as much total output. That's a ridiculous notion. I'm not saying we should completely subtract all government spending from GDP. Some spending like infrastructure is actually usefull (not necessarily better than would the government let private individuals spend their own money instead, but better than when the roads and bridges wouldn't exist at all). Other spending (like the police state, spying on citizens, all sorts of regulations, etc.) is actually harmful, in a way that people would probably pay additional money to free themselves of it, if it were legal. This spending would not only have to be left out from GDP, but actually subtracted since it's to nobodies benefit, but a disservice for which nobody would voluntarily pay. But of course no individual can decide how to really value government spending. There is no scientific way to do that.

I agree that there may be better ways to do this than spending. I don't believe in the liquidity trap and I think Scott Sumner's market monetarism will solve the problem without any need to fiscal policy. However, the statement of yours that government makes recessions worse is not actually supported by the evidence.

You are the one who came up with the liquidity trap when you initially said that a higher inflation target would be good, so that the central bank has more leeway. That's usually the Keynesian argument of the liquidity trap where you can't push real interest rates "far enough" below zero if "called for" when you have a low inflation target.

Ok, its not like the additional Y in C+I comes from consumption of capital, it comes from higher labor supply. Therefore, the additional investment should increase the supply of physical capital. Why does that eventually require a recession with low labor supply?

I don't like your story about aggregate demand. Here is my idea that I think will help you see where I'm coming from. Lets say we wake up tomorrow and the physical capital stock of the economy has doubled, but everything else including the number of workers stays the same. What happens over time in this economy? Do we ever have a recession?

But that's not what happened. Capital didn't just double. It increased, but at the same time debt increased (lower interest rates). The higher output will cause a deflation even in your scenario, if the money supply is fixed. The debt is still there and no company could pay it off.

Also, don't make the mistake to think of it as aggregate capital. There are different stages of production with different time scopes. Artificially low interest rates are going to increase investment in long term projects (the housing bubble comes to mind) more than in short term ones. Resources are scarce, though. It's not sustainable to increase consumption and investment at the same time. So one type of capital will quadruple while others will get smaller. And since people don't really need all the output from the first sector, a recession happens where capital gets reshuffled.

Again, thanks for the delicious red herring. It has nothing to do with what we're discussing, but both the Swede and Brit in me loves kippers with my eggs in the morning.

Yes, in Bizarro World, I'm sure. You didn't address the real world facts I called out, like all the incentives people have to continue paying, and all the disincentives that are always in place that prevent people from wanting to stop payments--even if they thought it might result in a write down. Already, the market is filled with myriad nightmare scenarios of people who even try to get a loan modification, only to find themselves caught in a bank's foreclosure trap.

No, I think you're just unaware that pretty much everything you are doing is from a decidedly normative base, with normative biases. Everything about Keynesian-spawned economics has an inescapable normative foundation. There is no way to wash your hands of that -- TO WIT:

See that? Right to the motives -- only a statist monetarist with a normative mindset would say such a thing, which begs the question regarding the mere existence of "correct economic policies". And for the record, I don't view a lack of economic policy in the macro as the equivalent to an economic policy. Zero is zero. The absence of a policy is not a policy.

You're in the mode of having "...some ideas about which are better than others."

How convenient for you. You get to spend your time attempting to describe a whole bunch of complex normative bullshit, along with the impossibility of ever accurately describing the erstwhile effects of their absence.

I'm just discussing positive economics and ignoring the rest of your insults. I don't care what you think it means. If you don't want to have a logical discussion, then do it and stop the dumb accusations. I want to have an intellectual discussion with people I disagree with that are willing to take a logical approach. You aren't really capable of doing that so far.

Its not a red herring at all. If increases in government spending are crowded out by decreases in private spending, then increases in government spending don't raise GDP.

All I'm saying is that making not paying better makes more people not pay. How dense are you to just not acknowledge that and move on?

It's not sustainable to increase consumption and investment at the same time.

Why not with higher labor supply?

The higher Y=C+I comes from higher labor supply, not from a decrease in some other type of investment. As you said, long term project investment will increase more, but both will increase.

I think we might be here all day if we keep discussing the rest of the thread so I'd rather discuss this material if you don't mind. I don't think you need comparisons of utility to know that poor people have higher marginal utility. That's an assumption that will get us closer to the right answer than ignoring the distribution. I agree with you about GDP, but consumption is the ultimate goal of production and it moves very closely with GDP. In other words, all the empirical work could be done for consumption instead of just GDP and it would work just as well.

The point about the liquidity trap is subtle. I think the Fed thinks that monetary policy is less effective at the zero lower bound. I disagree, I think printing money would still be effective. But in a world where the Fed believes in liquidity traps, the higher inflation target is a second best alternative.

If increases in government spending are crowded out by decreases in private spending, then increases in government spending don't raise GDP.

No, it's a shift in GDP in many cases, one that is not even accounted for, and you failed to acknowledge the point that I made--that there are massive portions of the so-called "private" sector that are nothing more than recipients of public sector funds, and yet are counted as GDP. And that gets to the heart of the mind-bogglingly ludicrous assumption that high GDP is even necessarily a good thing.

While GDP doesn't account for government debt, all of the expenditures that created that debt are very much counted. More importantly, the GDP does not account for private SAVINGS. Debt money redistribution by a deficit spending of government is INFLATIONARY. That means it taxes savings. If that money wasn't redistributed and spent by government, some of that could have ended up as overall private savings in America, not spending, not GDP. Not only would I call that A Very Good Thing, despite the fact that it would show up as a sharp DECLINE IN GDP (oooh, bad thing, right?), but I would also call that DECLINE IN GDP pretty solid evidence that government spending DID, in fact, raise GDP--and in what could be considered A Very Harmful Way.

All I'm saying is that making not paying better makes more people not pay. How dense are you to just not acknowledge that and move on?

LOL! Let's look at that final distillation of an axiomatic summation of yours once again:

"...making not paying better makes more people not pay."

Final answer? Do you see how nebulous, overly-generalized and non-specific to the argument at hand you had to get to even be able to make that fuzzy non-point? That's not logic. It's not even fuzzy logic. It's logic-evasive gibberish.

No, it's a shift in GDP in many cases, one that is not even accounted for, and you failed to acknowledge the point that I made--that there are massive portions of the so-called "private" sector that are nothing more than recipients of public sector funds, and yet are counted as GDP. And that gets to the heart of the mind-bogglingly ludicrous assumption that high GDP is even necessarily a good thing.

While GDP doesn't account for government debt, all of the expenditures that created that debt are very much counted. More importantly, the GDP does not account for private SAVINGS. Debt money redistribution by a deficit spending of government is INFLATIONARY. That means it taxes savings. If that money wasn't redistributed and spent by government, some of that could have ended up as overall private savings in America, not spending, not GDP. Not only would I call that A Very Good Thing, despite the fact that it would show up as a sharp DECLINE IN GDP (oooh, bad thing, right?), but I would also call that DECLINE IN GDP pretty solid evidence that government spending DID, in fact, raise GDP--and in what could be considered A Very Harmful Way.

LOL! Let's look at that final distillation of an axiomatic summation of yours once again:

"...making not paying better makes more people not pay."

Final answer? Do you see how nebulous, overly-generalized and non-specific to the argument at hand you had to get to even be able to make that fuzzy non-point? That's not logic. It's not even fuzzy logic. It's logic-evasive gibberish.

All you have left with is to disagree with tautology, which is what I've descended to with you after you fail to see even the most basic logic. Disagreeing with the dictionary seems to be your new past time. Its one that I don't want to really participate in anymore. Take a lesson from Danan, and try a different approach where both sides learn something from a discussion.

Anyway, GDP accounts identity

Y=C+I+G+NX

If every increase in G is crowded out by a decrease in C, then Y doesn't change. How stupid can you possibly be to disagree with me about this over multiple posts?

The last thing is just basic incentives. If you encourage something by making it more beneficial, more people will do it. Our argument about banks got to the point where I had to sink that low, to put a synonym in for "people respond to incentives". Why? because you either fail to acknowledge stuff like this or just never get it.

If every increase in G is crowded out by a decrease in C, then Y doesn't change. How stupid can you possibly be to disagree with me about this over multiple posts?

I don't know if you're being deliberately obtuse, or if only the points you're wanting to make are the only ones actually visible to your brain. Whatever the case, we didn't disagree on that point. Go back, read (no, really, actually read what I wrote), and you'll see that clearly. I referred to such a thing as a "shift". Meanwhile, other points were made, which you didn't acknowledge or respond to at all, showing that the absence of government spending would not necessarily result in a zero sum shift, which, if true, would mean that government spending DID, in fact, increase GDP. Go back and read, and you will see that just as clearly as well.

Since that moronic collectivist abstraction called GDP INCLUDES GOVERNMENT redistribution of wealth in the private sector, making those that are solely dependent on government spending an extension of that government, it would be kind of absurd to say that government spending doesn't increase government, wouldn't it?

The higher Y=C+I comes from higher labor supply, not from a decrease in some other type of investment. As you said, long term project investment will increase more, but both will increase.

The artificial interest rate distorts the market. Capital goods are not all the same. It makes a huge difference in what you invest. Every change in interest rates changes the composition of investment. It's not sustainable in the long run, because the wrong goods are being produced.

I think we might be here all day if we keep discussing the rest of the thread so I'd rather discuss this material if you don't mind. I don't think you need comparisons of utility to know that poor people have higher marginal utility. That's an assumption that will get us closer to the right answer than ignoring the distribution. I agree with you about GDP, but consumption is the ultimate goal of production and it moves very closely with GDP. In other words, all the empirical work could be done for consumption instead of just GDP and it would work just as well.

No, we don't know if poor people have a higher marginal utility for money than rich people. That's an entirely unscientific statement, unless you can back it up with evidence. As long as we don't have a measurement device for "utils" we can't say something like that. The opposite statement, that rich people have higher MU, is just as true. If you really care so much about positive economics, you better keep redistribution out of the discussion, because that's an entirely normative matter, which you said you won't talk about.

The point about the liquidity trap is subtle. I think the Fed thinks that monetary policy is less effective at the zero lower bound. I disagree, I think printing money would still be effective. But in a world where the Fed believes in liquidity traps, the higher inflation target is a second best alternative.

You don't seem to get the point of the liquidity trap. If the Fed has an inflation target of 2% and the nominal interest rate is at almost 0%, they can't do anything to decrease real interest rates further. If they print more money they increase inflation over their target, which they are theoretically not allowed to. So they could bring real interest rates down even lower, but are not allowed to because of the target (thank god). I don't see any way around this argument.

Or to put it differently, the Fed already increases the money supply enough to reach a 2% inflation target. If they want to get real interest rates lower, they have to print money. If they print money, it's value goes down. If it's value goes down, inflation gets higher.

If every increase in G is crowded out by a decrease in C, then Y doesn't change. How stupid can you possibly be to disagree with me about this over multiple posts?

Let's say NX = 0.

Y=C+I+G

Let's also assume the government doesn't borrow: G = T

Obviously I+C=Y-T => I+C=Y-G

In this case, every increase in G does crowd out C+I, because if the government's only source of funding is taxation, every increase in G has to come from an increase in T, which lower C+I.

If the government can borrow money, however, it depends from whom it borrows. If it borrows only from people within the country, the demand for money goes up (a shift to the right) interest rates go up and overall funds loaned out increase, while private investment decreases (the private demand for money didn't change but the additional governmental demand created higher equilibrium interest rate, at which private businesses want to invest less). Also, since it's only borrowing from within the country, every Dollar loaned to the government has to be forgone consumption today (or a loan a private business didn't get, as explained earlier).

So as long as the Y=C+I+G identiy exists, every Dollar the government spends, is indeed a Dollar not spent by private individuals.

Only if we look at foreign debt, the picture changes a little bit. Norway for example exploited huge oil reserves and thus was attractive for investors all over the world. However, once the loans are repaid, the investors want to consume eventually. If there are many currency holders from outside the country wanting to consume goods, this obviously decreases domestic consumption (higher prices, etc.). That's not problematic in Norway's case, since they actually invested in something of real value to consumers, so they are still better off than without the loans.

The US is a little different because the Dollar is a reserve currency. Many foreign lenders hold Dollar-denominated debt just for the sake of holding it and keep renewing it, without any imidiate interest in consuming products made in the US. This is btw one the major reasons consumer prices in the US rise slower than asset prices. The US was not an attractive investment destination because of it's promising capital accumulating projects. In fact, the US blew all that additional money on consumption, either by the government or private consumption (just look at the enormous trade defict). And the investment projects they did engage in are not needed and have never been sustainable, for reasons already explained. At some point foreign investors are not going to invest into US bonds any longer. Not only is this going to be abysmal for the US treasury, causing the Fed most likely to expand the money supply even further, but that's going to mean a forced shift in the trade balance.

The artificial interest rate distorts the market. Capital goods are not all the same. It makes a huge difference in what you invest. Every change in interest rates changes the composition of investment. It's not sustainable in the long run, because the wrong goods are being produced.

No, we don't know if poor people have a higher marginal utility for money than rich people. That's an entirely unscientific statement, unless you can back it up with evidence. As long as we don't have a measurement device for "utils" we can't say something like that. The opposite statement, that rich people have higher MU, is just as true. If you really care so much about positive economics, you better keep redistribution out of the discussion, because that's an entirely normative matter, which you said you won't talk about.

You don't seem to get the point of the liquidity trap. If the Fed has an inflation target of 2% and the nominal interest rate is at almost 0%, they can't do anything to decrease real interest rates further. If they print more money they increase inflation over their target, which they are theoretically not allowed to. So they could bring real interest rates down even lower, but are not allowed to because of the target (thank god). I don't see any way around this argument.

Or to put it differently, the Fed already increases the money supply enough to reach a 2% inflation target. If they want to get real interest rates lower, they have to print money. If they print money, it's value goes down. If it's value goes down, inflation gets higher.

I will stipulate that the higher investment is unsustainable, in the sense that it will not continue forever. However, given that higher I and higher C both come from higher labor supply, they are not technologically unsustainable, they could be maintained with higher labor supply. However, we both believe in worlds where they will eventually come back down, so might as well not argue a technicality and just agree with you.

On the idea of the composition of investment. As I said, both short term and long-term investment increase, maybe for different amounts, but they both increase nonetheless. Even if they eventually go back to normal levels, that doesn't explain the recession. Why do you think I goes from a higher than normal level to a lower than normal level, when we have the alternative of going back to a normal level that seems more reasonable.

In other words, the notion that high investment is unsustainable, which we both agree to, does not imply a crash. It could imply many different things depending on how the economy works. Higher investment than optimal in a particular industry does not imply a crash either.

You basically have to come up with a reason why adding physical capital in any industry can be a bad thing. Remember the physical capital comes from extra work, not lost consumption or consumption of capital. Even if one industry has a lot more capital than it will need in the long-run, how is this ever a bad thing, if there is no industry with less capital than is optimal?

On the topic of liquidity traps, people generally don't understand the distinction between the zero lower bound, which is what you are describing and a liquidity trap, where dropping money from helicopters does not stimulate the economy or even create inflation. Its an old idea that when interest rates are zero, any money dropped is just saved in mattresses and has no economic impact. I don't think its reasonable and you probably agree but its important to understand how extreme of a position the liquidity trap is.

In this case, every increase in G does crowd out C+I, because if the government's only source of funding is taxation, every increase in G has to come from an increase in T, which lower C+I.

If the government can borrow money, however, it depends from whom it borrows. If it borrows only from people within the country, the demand for money goes up (a shift to the right) interest rates go up and overall funds loaned out increase, while private investment decreases (the private demand for money didn't change but the additional governmental demand created higher equilibrium interest rate, at which private businesses want to invest less). Also, since it's only borrowing from within the country, every Dollar loaned to the government has to be forgone consumption today (or a loan a private business didn't get, as explained earlier).

So as long as the Y=C+I+G identiy exists, every Dollar the government spends, is indeed a Dollar not spent by private individuals.

Only if we look at foreign debt, the picture changes a little bit. Norway for example exploited huge oil reserves and thus was attractive for investors all over the world. However, once the loans are repaid, the investors want to consume eventually. If there are many currency holders from outside the country wanting to consume goods, this obviously decreases domestic consumption (higher prices, etc.). That's not problematic in Norway's case, since they actually invested in something of real value to consumers, so they are still better off than without the loans.

The US is a little different because the Dollar is a reserve currency. Many foreign lenders hold Dollar-denominated debt just for the sake of holding it and keep renewing it, without any imidiate interest in consuming products made in the US. This is btw one the major reasons consumer prices in the US rise slower than asset prices. The US was not an attractive investment destination because of it's promising capital accumulating projects. In fact, the US blew all that additional money on consumption, either by the government or private consumption (just look at the enormous trade defict). And the investment projects they did engage in are not needed and have never been sustainable, for reasons already explained. At some point foreign investors are not going to invest into US bonds any longer. Not only is this going to be abysmal for the US treasury, causing the Fed most likely to expand the money supply even further, but that's going to mean a forced shift in the trade balance.

I know a lot of people have ideas like this, but its important to understand that Y=C+I+G is an accounting identity and says nothing about how these things are determined. Your statement about crowding out under a balanced budget is just mathematically untrue. In addition, the balanced budget assumption is a little absurd in light of the current political environment.

Anyway, a counter example would be enough to show you this.

Imagine C=a+MPC(Y-T) and I=constant

as a silly counterexample. This would be an IS-LM model with a horizontal LM curve. Anyway, a change in government spending deltaG and taxes deltaT of the same magnitude, which maintains a balanced budget, still raises Y.

deltaY=deltaG deltaC=0.

You can make I depend on the interest rate, and then there is some crowding out of G by decreased I.

Anyway, this is a silly example, but one counterexample is all you need to disprove a mathematical statement so there you go.